Central banks, including the Bank of Canada, have failed to restart key global economies. They keep trying, mostly with near-zero interest rate policies and various forms of quantitative easing, but the world remains mired in slow growth, or worse.

It seems well past time for a broad public discussion of the foundations of current monetary policy and its role in shaping the current state of the world economy. If central bankers had gotten it right in the first place, the current government obsessions with the need for deficits and fiscal stimulus would be unnecessary.

Much debate over monetary policy is already happening, although mostly in the hallways of the economics profession and outside official and public circles. In Canada, so far, the debate has been muted by the daily macro-musings about when the next interest rate cut will or will not take place.

But more debate is likely to break out. A new economic brief from the C.D. Howe Institute by Montreal economist Steve Ambler suggests the time has come for a major rethink of monetary policy.

In the brief, to be released Thursday, Ambler takes on the mainstream interpretations of the causes of the Great Recession and attempts to drag the Bank of Canada back to some key monetary basics.

Specifically, the bank should review its obsession with interest rates and get back to the business — advocated by the monetarist school of economics, but abandoned years ago—of targeting the money supply.

Monetary policy is, to say the least, arcane, and it is by no means certain that Ambler and other economists, many in the so-called “market monetarist” school, actually have solutions to the economic stagnation in Canada and elsewhere. But they do have a credible story to tell of how central banks helped create the recession and ultimately prolonged the slow-growth era the world now grapples with.

It’s a story that needs telling, and Ambler nicely summarizes that history of monetary malpractice in an appendix titled “A Monetary Interpretation of the Great Recession.” It begins with a brief sentence that hints that the U.S. Federal Reserve was a prime contributor to the U.S. housing bubble. Regardless of that possibility, Ambler writes, “a strong case can be made that the stance of monetary policy during the first three quarters of 2008 was overly restrictive.” The Fed kept rates high “even though the U.S. economy had already entered a recession.”

The effect of the rate policy, and the subsequent squeeze on financial institutions as the mortgage market collapsed, was a massive decline in the broad measures of money supply, a tabulation central bankers no longer track.

“The evidence is interpreted by the advocates of the monetary approach to suggest that major central banks allowed money growth to fall and that this may have at least contributed to turning a mild recession into the most important worldwide recession since the Great Depression.”

The Fed then launched its now famous quantitative easing program, buying up hundreds of billions of dollars in government bonds and mortgage-backed securities. That may have helped boost the money supply, but the benefits were wiped out by other policies.

The Fed began to pay interest to banks on their holdings of reserves. “This created a disincentive for banks to lend.” Instead of making loans, the banks “could earn low but safe rates of return by leaving reserves parked with the Fed.”

Another complication was the global move by regulators — supported by central banks — to recapitalize the banking industry, sucking money out of the economy. Ambler, citing Johns Hopkins economist Steve Hanke, says the push to recapitalize banks in Canada, Europe and the United States “had the effect of putting a brake on the rate of growth of broad measures of the money supply.”

Ambler argues that central banks, including the Bank of Canada, have erred in depending exclusively on interest rates to stimulate the economy. As rates were lowered to zero, the banks ignored the impact of policy on the money supply.

In the monetarist view, one long held by C.D.Howe economists William Robson and David Laidler, money growth is a key indicator of a country’s economic dynamics. Money growth measures the degree to which banks are lending and the economy is active — or overactive. Too much money growth could lead to inflation; too little, to recession.

The Bank of Canada and other central banks abandoned the practice of measuring the money supply years ago. It was interest rates or nothing. In an interview, Ambler said this exclusive focus “has been breaking down recently.” The alternative, he says, is for the Bank of Canada to get back to targeting the money supply, which it now dismisses and ignores as a meaningful indicator.

Back in the 1990s, the bank tracked the money supply the way markets currently track interest rates. It is time, says Ambler, for the Bank of Canada to get back to “some kind of level targeting to make it credible.” Instead of looking at future rate cuts, the bank should begin preparing some form of quantitative easing. “The Bank of Canada,” says Ambler, “should aim to provide monetary stimulus through open market operations or through direct purchase of securities from the private sector.”

Whether or not that’s the only monetary option, a new debate over the limits of central banking’s interest rate policy and a fresh focus on the importance of money supply is long overdue.

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